Next week’s vote on the appointment of KPMG plc at Rentokil (15 May) looks to be more than usually interesting. While the cut price deal struck by KPMG offers a 30% headline discount, concerned investors are questioning the real hidden costs of blurring lines of accountability to management on the one hand and the real audit client – shareholders.

In an interview with the Scottish Institute of Chartered Accountants earlier this year. Oliver Tant , KPMG CEO said that the portrayal of the arrangement was “a gross misrepresentation”.  He explained that: “We constantly get asked to rely on internal audit but frequently internal audit is doing the same things that we are doing; in some cases repeating work we have already done. So in certain situations it would be perfectly sensible for us to share the results of our work.”

The concept of external auditors carrying out any internal audit role has been a hot potato since the Enron and WorldCom scandals. New rules were put in place to split the roles to avoid auditors becoming too tied to the company and creating a conflict of interest.

External audit guidelines warn against two threats when an external auditor takes on internal audit work:  

  • Self Review Threat: External Audit relying heavily on its own Internal Audit work
  • Management Threat: Internal auditors assuming the role of management (in determining the scope and nature of internal audit services or the design and implementation of internal controls)

 (Accounting Practices Board, Ethical Standard 5, Para. 39-47).

Certainly as currently explained to shareholders, the arrangement would probably be illegal in France and untenable for any issuer with a dual UK/US listing. President of the Institute of Internal Audit (IIA),  Richard Chambers, has gone on record as stating that he “believes that even if allowed by law or statute, this practice – at a minimum – creates a perceived impairment of independence and erodes public trust.”

Mainstream media understanding and reporting of governance failures has revolved around executive pay in recent years. That’s understandable, it grabs the headlines and makes for good copy. What they often forget is that corporate governance is what it is today because of investiations into audit failure prompted by the likes of BCCI, Polly Peck et al. Accounting standards are jsut as implicated in RBS’ woes as Fred Goodwin’s pay packet.

With the news that the PCAOB’s recent inspection of Deloitte highlighted 20% of 73 audits had significant issues, nervous shareholders are looking for signs that audit objectivity and independence are working in their favour, not management’s. 

It’s rare to see any audit related resolutions to figure in Manifest’s league tables of significant proxy dissent. May 15 could well see that change.

Last Updated: 8 May 2010
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